What’s a Roth IRA?
A Roth IRA is a retirement plan that allows you to invest in stocks, bonds, mutual funds, CDs/share certificates or real estate. You can open one at a financial institution, through investment companies or with a broker.
The main advantage of a Roth IRA over a traditional IRA is taxes. With a traditional IRA, contributions (money put in) are tax deductible. For example, if you made $15,000 and put $1,000 towards a traditional IRA, you’d pay taxes for only $14,000 of income that year. But when it comes time to withdraw the investment, you’ll be taxed for that money and its earnings at the current tax rate, which varies depending on your level of income.
With a Roth IRA, you pay income taxes on the investment before contributing. When the money comes out decades later, there are no taxes to pay on either the principle (because you already paid it before it went in) or on the gains. This makes Roth IRAs a great choice for the younger crowd, because income at the beginning of a career will likely be lower (less taxes) than income at retirement (higher taxes).
The Fine Print
Below are the most important restrictions and rules to consider:
• Contribution eligibility. To contribute, you must have at least some taxable compensation (income, wages, etc.). If you earn less than $105,000 as a single filer or $167,000 as married filing jointly, you’re good to go. If you earn more, congratulations, but after those limits your contribution limit is phased out. If you make $120,000 as a single filer or $177,000 as married filing jointly, you can’t contribute to a Roth IRA at all.
• Contribution limits. There’s a limit to how much money you can contribute to a Roth IRA in any given year — it’s $5,500 for 2016 ($6,500 for those 50 years or older beefing up their investment at the last minute). This limit is adjusted, so visit irs.gov every January to see what the limit is for the New Year.
• Distributions. You may face penalties if you don’t follow the rules governing distributions. First, you must be at least 59 ½ years old at the time of distribution. Second, the account must be at least five years old. There are exceptions, though: early distributions can be penalty free if the money is used to purchase a first-time home, to pay some unreimbursed medical expenses, to pay for higher education or if the Roth IRA owner becomes disabled or dies.
Here are a few pointers to help manage your Roth IRA:
• Set up automatic contributions. Most financial institutions that offer Roth IRAs also offer the ability to automatically contribute throughout the year. You can set the schedule and amounts, and put it on autopilot.
• Consult an online calculator. Use an online calculator to help you understand many aspects of Roth IRA contributions and distributions.
Research more about retirement savings, including Roth IRAs, at irs.gov. When you’re ready to invest, visit a financial or investment professional at your financial institution for suggestions, advice and options.
Investing just $3,000 per year in a Roth IRA until retirement at 65 (with an estimated return of 8 percent) results in $400,000 more by starting at age 20 than at age 25. The time to start investing is now, even if it’s just a little bit.